WEAKNESSES

RISK ASSESSMENT

Growth is expected to stabilise in 2016

In 2015, growth fell due to slower coal exports to China and also slower FDI inflows, in a context of lower commodity prices and uncertainties over the regulatory framework.

In 2016, growth is expected to stabilise. The growth rate will, however, remain well below the average observed between 2010 and 2014 (11.3%). Mongolia's economy will be hit by the drop in commodity prices, first and foremost the price of coal. In addition, the country looks set to record a contraction in export volumes. The country appears vulnerable to the slowdown in the Chinese economy - the Middle Kingdom being the recipient of 90% of its exports. Nonetheless, the mining sector should benefit from the signing of the agreement between Rio Tinto and the government regarding the second phase of the Oyu Tolgoi mine (one of the world's largest gold and copper reserves). This agreement has helped restore, to some extent, investor confidence in the authorities. FDIs in the country have slowed because of the difficulties in the mining sector, but also because of the worsening business climate. Following the referendum held in February 2015, endorsing public willingness to accept foreign investment in the mining sector, the prime minister has worked to restore investor confidence. However, FDIs are likely to remain constrained by the gloom in this same sector and the Chinese slowdown.

Meanwhile, private demand is affected by the change in economic policy. After several years of an expansionary policy mix, the government has introduced fiscal consolidation and monetary tightening. Finally, the subsistence agriculture based on cattle rearing remains vulnerable to climatic shocks and disease. In this context, inflation will remain high in 2016.

Balance of payments will remain fragile

The budget deficit is likely to fall again in 2016. The country will continue to carry out spending cuts. However, the room for manoeuvre on the budget is very slim, as the country is vulnerable to the volatility of budgetary resources from mining. Moreover, elections will take place during 2016 and could lead the government into extra spending. Much infrastructure spending is off-balance sheet (in particular via theDevelopment Bank of Mongolia). Meanwhile, external debt has risen sharply and represented almost 152% of GDP at the end of 2015. External debt is mostly held by the private sector, with over half related to intercompany lending associated with FDIs.

Moreover, the current account deficit is expected to remain substantial due to significant imports of capital goods needed for the exploitation of mineral deposits. In addition, exports will be affected by the fall in commodity prices and the Chinese slowdown. Despite the improved prospects offered by the agreement between Rio Tinto and the government, FDIs will remain below their potential. Still, while the tugrik is under considerable downward pressure, the signing of the agreement enabled the currency to appreciate slightly in spring 2015 before its exchange rate against the dollar fell again from the summer. 2016 is likely to be marked by new downward pressures. In this context, the level of foreign exchange reserves has fallen considerably in recent years, making the country vulnerable to sudden capital flight. They fell 58% between January 2013 and July 2015 and still represent less than one month of imports.

Tense political situation in the run-up to the 2016 elections

On 5 November 2014, the Parliament removed Prime Minister Norov Altankhuyag (Democratic Party) from office on grounds of his inability to resolve the economic situation. After internal negotiations within the Democratic Party and a parliamentary vote boycotted by the opposition, Chimed Saikhanbileg was appointed as Prime Minister on 21 November 2014. His policy is to promote the country's attractiveness and in February 2015 he initiated a referendum aimed at obtaining public approval for the development of the mining sector. Nonetheless, the coalition set up with the Mongolian People's Revolutionary Party and the Justice Coalition (other small populist parties) has proved fragile. The 6 Mongolian People's Party (MPP) ministers were forced out of government in August. The prime minister's coalition appears increasingly unstable and the parliamentary elections scheduled to take place in 2016 could be brought forward to the first quarter. The outcome of the elections is likely to affect relations between investors and the authorities, Chimed Saikhanbileg having worked to arrive at an agreement over theOyu TolgoiandTavan Tolgoimines.

Finally, governance shortcomings are the country's Achilles heel and the risk of social tension needs to be watched.